Prohibited Transactions

August 05, 2024

3986.02 / What developments have emerged regarding a fiduciary’s consideration of environmental, social and governance (ESG) issues in making investment decisions?

Late in 2020, the DOL finalized a rule that would limit consideration of environmental, social and governance (ESG) factors when retirement plan fiduciaries are selecting plan investments without violating their fiduciary duties. Plan fiduciaries are obligated to act solely in the interest of plan participants and beneficiaries when making investment decisions. Under the final rule, the DOL said that plan fiduciaries must select investments based on pecuniary, financial factors and that it would apply an “all things being equal test”--meaning that fiduciaries were not prohibited from considering or selecting investments that promote or support non-pecuniary goals, provided that they satisfy their duties of prudence and loyalty in making the selection. This rule was seen as limiting fiduciaries’ ability to consider ESG factors in investing. However, earlier in 2021, the EBSA announced that it would not enforce this Trump-era rule, so that plan fiduciaries may once again consider ESG factors in making investment decisions. On November 22, 2022, the DOL released a new final rule on ESG investing. The rule retains many prior elements, yet is generally expected to make it easier for plan fiduciaries to consider ESG factors in determining investment strategy. According to the rule, a plan fiduciary’s determination with respect to an investment or investment strategy must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis. The DOL further states that the analysis should use appropriate investment horizons consistent with the plan’s investment objectives and should account for the funding policy of the plan established under ERISA. Under the final rule, however, fiduciaries will not be prohibited from considering collateral benefits aside from investment returns when there is an essential “tie” in the context of the investment analysis. Fiduciaries will also not violate their duty of loyalty merely because they take participant preferences into account when building their menu of otherwise prudent investment options. The new rule does not contain any separate standard for QDIAs. This ESG investing rule continues to generate controversy, so practitioners should pay close attention to developments in this area.

August 05, 2024

3986.01 / What requirements must be satisfied for an investment advice fiduciary to qualify under the DOL’s fiduciary PTE 2020-02?

<div class="Section1"> In 2020, the DOL introduced a new class exemption, PTE 2020-02. The exemption grants relief to financial advisors and institutions who provide investment advice (including retirement-related and rollover advice, see Q 3977.01) if the terms of the PTE are satisfied.<a href="#_ftn1" name="_ftnref1">1</a> In creating the PTE 2020-02, the DOL’s stated goal was to provide impartial conduct standards that are in line with guidance released by other regulators, including the SEC Regulation Best Interest and state-level fiduciary rules. To qualify under the PTE 2020-02, advisors must provide advice in accordance with impartial conduct standards, which include standards related to: (1) acting in the client’s best interests, (2) reasonable compensation, (3) refraining from misleading statements, (4) disclosure, (5) conflict mitigation and (6) retroactive compliance review (see below).<a href="#_ftn2" name="_ftnref2">2</a> The exemption, which was finalized late in 2020, is available to registered investment advisers, broker-dealers, banks, and insurance companies (financial institutions) and their individual employees, agents, and representatives (investment professionals) that provide fiduciary investment advice to retirement investors. The exemption defines retirement investors as plan participants and beneficiaries, IRA owners, and plan and IRA fiduciaries. In determining whether an advisor is a fiduciary who may take advantage of the exemption, the new 2024 standard will apply (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>). The exemption’s relief also specifically applies to otherwise prohibited transactions related to investment advice about retirement plan rollovers.  In their 2024 release, the DOL also clarified that robo-advice providers can use PTE 2020-02. <hr> Planning Point: The DOL has proposed a new rule that would make the process for obtaining a prohibited transaction exemption much more difficult. If passed, the changes will apply only prospectively, 90 days after the publication of the final rule in the Federal Register. The proposed regulations would require that communications with the DOL prior to submitting a formal application for exemption will become part of the administrative record that can be requested by the public. Applicants would not be permitted to approach the DOL on an anonymous basis. The regulations would impose new terms with respect to the independent fiduciary or appraiser that may be required. The current regulations provide information about when the fiduciary or appraiser will be considered “independent,” providing that the fiduciary or appraiser is independent if less than 2% of their revenue is derived from parties to the transaction (though it is currently possible that they could achieve independent status if the revenue is less than 5%). The new rules would make the standard stricter and require analysis of the revenue from the prior tax year and projected revenue for the current year. If an appraiser and a fiduciary are required, the appraiser must be independent of both the fiduciary and the applicant. It would also be possible that the individual could be deemed not “independent” if they have an interest in the transaction or future transactions of a similar type. <hr> Impartial Conduct Standards Relief under the exemption is conditioned on adhering to impartial conduct standards, as follows: Best Interests Standard. The best interest standard follows longstanding legal concepts. It is generally satisfied if investment advice “reflects the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the investor, and does not place the financial or other interest of the [advisor/firm] or any affiliate, related entity or other party ahead of the interests of the investor, or subordinate the investor’s interests to their own.” The preamble is careful to note that the PTE does not create a duty to monitor—although a duty to monitor could be generated depending upon whether an investment could prudently be recommended to the investor absent ongoing monitoring.<a href="#_ftn3" name="_ftnref3">3</a> Reasonable Compensation Rule. The reasonable compensation standard requires that compensation not be excessive, as measured by the market value of the particular services, rights, and benefits the advisor is delivering. The reasonableness of fees will depend on the particular facts and circumstances at the time of the recommendation. Several factors inform whether compensation is reasonable, including the market price of services provided and/or the underlying assets, the scope of monitoring, and the complexity of the product. No single factor is controlling in determining whether compensation is reasonable. The important question is whether the charges are reasonable in relation to what the investor receives. Firms and advisors have no obligation to recommend the transaction that is the lowest cost or that generates the lowest fees without regard to other factors.<a href="#_ftn4" name="_ftnref4">4</a> The exemption also requires financial firms and advisors to seek to obtain the “best execution” of the investment transaction reasonably available under the circumstances. This duty is satisfied if the advisor complies with applicable federal securities laws, including those imposed by the SEC and FINRA that are beyond the scope of this discussion.<a href="#_ftn5" name="_ftnref5">5</a> No Misleading Statements. This element requires that statements by the both the financial firm and the advisor to the investor about the recommended transaction and other relevant matters are not materially misleading at the time they are made. The preamble to the PTE states that “other relevant matters” include fees and compensation, material conflicts of interest, and any other fact that could reasonably be expected to affect the investor’s investment decisions.<a href="#_ftn6" name="_ftnref6">6</a> Disclosure Requirement. Financial firms are required to make written disclosure of their fiduciary status to investors prior to engaging in any transactions covered by the exemption. The disclosure must contain a written description of the services to be provided and material conflicts of interest arising out of the services and any recommended investment transaction. The disclosures should be in plain English, considering the investor’s level of financial experience. The PTE does not require specific disclosures to be tailored for each investor or each transaction as long as a compliant disclosure is provided before engaging in the particular transaction.<a href="#_ftn7" name="_ftnref7">7</a>  In their 2024 amendments, the DOL offered clarification for advisors who discuss recommendations and investment strategies in conversations that take place before the advisor is actually hired by the client.  For timing purposes, it is sufficient for the advisor to make the required disclosures at or before the time a covered transaction occurs.  In these types of situations, the covered transaction is deemed to have occurred at the later of (1) the date the recommendation is made, or (2) the date the advisor becomes entitled to compensation, whether payable now or in the future, because of making the recommendations.<a href="#_ftn8" name="_ftnref8">8</a>  The DOL also clarified that these types of “hire me” conversations do not necessarily create fiduciary status, but the DOL did not specifically exempt them. Financial Firms’ Policies & Procedures Requirement. The exemption requires financial firms to establish, maintain and enforce written policies and procedures prudently designed to ensure compliance with the impartial conduct standards. These policies and procedures should be designed to mitigate conflicts of interests generally and avoid incentives to violate the impartial conduct standards.<a href="#_ftn9" name="_ftnref9">9</a> Administrative Details The final PTE adds a self-correction procedure. Advisors and firms will not be treated as violating the prohibited transaction rules if the advisor corrects the violation, notifies the DOL via email within 30 days and the correction occurs within 90 days of when the advisor learned of the violation. The advisor will also be required to make the investor whole again for any losses that occurred because of the violation. The financial institution is also required to notify the person responsible for conducting retrospective compliance reviews under the PTE. This retrospective review must be conducted at least annually. Under the final PTE, it must be certified by a senior officer of the financial institution. That officer must certify that the financial institution has procedures and policies in place designed to ensure compliance with the PTE. The officer must further certify that the firm has procedures in place to both test the effectiveness of their policies and modify them to ensure ongoing compliance. The final PTE introduces a new disclosure document that must be provided to retirement investors before recommending a rollover transaction. The written document must describe the specific reasons for recommending a rollover between two accounts—as well as acknowledge the advisor’s status as a fiduciary. BICE: Administrative Exemption: 2016-01 Prohibited Transaction Exemption 2016-01<a href="#_ftn10" name="_ftnref10">10</a> added the Best Interest Contract (BIC) Exemption as part of the Department of Labor’s 2016 Fiduciary Rule (now repealed), designed to minimize conflicts of interest and provide that advisors act in the employee or participant’s best interests. Under the BIC Exemption, financial institutions and advisors could receive variable compensation by acknowledging they were fiduciaries in providing investment advice and adhere to impartial conduct standards. In addition, the financial institution was required to have policies and procedures in place designed to ensure compliance with the impartial conduct standards, detect and record any material conflicts of interest, and designate a person responsible for compliance with the impartial conduct standard. Specified information had to be disclosed to participants prior to or at the time transactions based on the advice occur. That information was also required to be posted on a website maintained by the firm. Historical Background After the Fifth Circuit vacated the 2016 DOL fiduciary rule, the DOL removed the Best Interest Contract Exemption (BICE) in 2020.  In June 2020, the DOL released a fiduciary PTE 2020-02 to replace the 2016 rule (see the heading below for a discussion of BICE, as it would have applied under the 2016 DOL rule). The DOL has also extended the nonenforcement policy under FAB 2018-02 through January 31, 2022. As a result, the DOL did not pursue prohibited transactions claims against investment advice fiduciaries who were working in good faith to comply with the impartial conduct standards under PTE 2020-02 prior to that date. It also did not treat these fiduciaries as violating the prohibited transaction rules during this period. The DOL did not enforce the “specific documentation” and disclosure requirements for rollovers under PTE 2020-02 through June 20, 2022. Aside from the rollover exception, most other requirements were subject to full enforcement as of February 1, 2022. The retroactive compliance review deadline is six months after the end of the year (June 30, 2023 for 2022 transactions).  The review must be certified by a senior executive officer of the institution that provides the investment device.  Clients should also remember that any documentation or records related to the review should be retained for at least six years after the review is submitted. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  See Improving Investment Advice for Workers & Retirees, ZRIN 1210-ZA29. <a href="#_ftnref2" name="_ftn2">2</a>.  Sec. II(d). <a href="#_ftnref3" name="_ftn3">3</a>.  Sec. II(a)(1). <a href="#_ftnref4" name="_ftn4">4</a>.  Sec. II(a)(2). <a href="#_ftnref5" name="_ftn5">5</a>.  Sec. II(a)(2)(B). <a href="#_ftnref6" name="_ftn6">6</a>.  Sec. II(a)(3). <a href="#_ftnref7" name="_ftn7">7</a>.  Sec. II(b). <a href="#_ftnref8" name="_ftn8">8</a> 29 CFR Part 2550. <a href="#_ftnref9" name="_ftn9">9</a>.  Sec. II(c). <a href="#_ftnref10" name="_ftn10">10</a>.  81 Fed. Reg. 21002, corrected by 81 Fed. Reg. 44773. </div></div>

March 13, 2024

3981 / What is a “disqualified person” for purposes of the prohibited transaction rules?

<div class="Section1"> A disqualified person is: (1)  a fiduciary (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3982">3982</a>); (2)  a person providing services to the plan; (3)  an employer or employee organization, any of whose employees or members are covered by the plan; (4)  a 50 percent owner, directly or indirectly, of an employer or employee organization described in (3); (5)  a family member of any person described in (1) through (4); (6)  a corporation, partnership, trust, or estate that is 50 percent or more owned by any person described in (1), (2), (3), or (5); (7)  an officer, director, 10 percent or more shareholder, or highly compensated employee of a person described in (3), (4), or (6); or (8)  a 10 percent or more (in capital or profits) partner or joint venturer of a person described in (3), (4), or (6).<a href="#_ftn1" name="_ftnref1">1</a> Family Member A family member is defined as a spouse, ancestor, lineal descendant, or any spouse of a lineal descendant.<a href="#_ftn2" name="_ftnref2">2</a> Highly Compensated Employee A highly compensated employee is defined as any employee earning 10 percent or more of the yearly wages of an employer.<a href="#_ftn3" name="_ftnref3">3</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 4975(e)(2). <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 4975(e)(6). <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 4975(e)(2)(H). </div></div>

March 13, 2024

3980 / What are prohibited transactions?

<div class="Section1"> Any transaction, whether direct or indirect, between a plan and a disqualified person (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3981">3981</a>) constitutes a prohibited transaction under the IRC. These transactions include: (1)  a sale, exchange, or lease of any property, including a transfer of property subject to a security interest assumed by the plan or placed on it within 10 years prior to the transfer;<a href="#_ftn1" name="_ftnref1">1</a> (2)  lending of money or other extension of credit; (3)  furnishing of goods, services, or facilities; and (4)  the transfer of plan assets or income to, or use of them by or for the benefit of, a disqualified person. Note, however, that there are statutory and regulatory exemptions from what would ordinarily be a prohibited transaction. <hr> Planning Point: Before a plan enters any transaction, counsel should scrutinize the transaction to determine whether it is prohibited. If the transaction is prohibited, counsel should first determine whether a statutory exemption is available under ERISA Section 408. If so, counsel should make sure that each requirement is met, that the trustees approve the transaction and document the decision-making process in the plan’s minutes, and that the transaction is adequately documented in writing. If no statutory exemption is available, then counsel should check class action exemptions to determine if one applies. Finally, if no other exemptions are available, counsel can apply for an individual exemption.<a href="#_ftn2" name="_ftnref2">2</a> <hr> It is a prohibited transaction for a disqualified person who is a fiduciary to deal with income or assets of a plan in his or her own interest or to receive consideration for his or her own personal account from a party dealing with the plan in connection with a transaction involving plan income or assets.<a href="#_ftn3" name="_ftnref3">3</a> Title I of ERISA prohibits a fiduciary from acting, in any transaction involving the plan, on behalf of anyone having interests adverse to those of the plan or plan participants or beneficiaries.<a href="#_ftn4" name="_ftnref4">4</a> The Department of Labor has issued final regulations on ERISA Section 408(b)(2) required fee disclosures by service providers to plan fiduciaries and participants ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4124">4124</a>).<a href="#_ftn5" name="_ftnref5">5</a> The definition of a plan for this purpose includes not only any qualified pension, profit sharing, stock bonus, or annuity plan, but also an individual retirement plan ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3641">3641</a>), health savings account (“HSA”) ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="399">399</a>), Archer medical savings account (“MSA”) ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="431">431</a>), or Coverdell education savings account. The term “plan” includes such plans even after they are no longer qualified. Government and church plans are excluded.<a href="#_ftn6" name="_ftnref6">6</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 4975(f)(3). <a href="#_ftnref2" name="_ftn2">2</a>.  Final Department of Regulations on Prohibited Transaction Exemption Procedures are available at 29 CFR §§ 2570.30 – 2570.52. <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 4975(c)(1). <a href="#_ftnref4" name="_ftn4">4</a>.  ERISA § 406(b)(2). <a href="#_ftnref5" name="_ftn5">5</a>.  29 CFR § 2550.408b-2(c). <a href="#_ftnref6" name="_ftn6">6</a>.  IRC § 4975(e)(1). </div></div>

March 13, 2024

3982 / Who is a fiduciary for purposes of the prohibited transaction rules?

<div class="Section1"> The definition of investment advice fiduciary continues to change.  Under the 2024 rule, a financial services professional is classified as an investment advice fiduciary if (1) the provider offers investment advice or makes investment recommendations to a retirement investor, (2) the advice or recommendation is made for a fee or other compensation and (3) the financial services provider either specifically states that they are acting as an investment advice fiduciary or makes the recommendation within a professional relationship in which an investor would reasonably expect to receive sound investment recommendations that are in their best interest.  See Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> for a detailed explanation. Historically, a fiduciary has been a person who has discretionary authority or control over plan management or administration or disposition of plan assets, or who renders investment advice for a fee or other compensation, direct or indirect, with respect to any money or other property of the plan.<a href="#_ftn1" name="_ftnref1">1</a> A person renders investment advice if advising trustees as to the value of property or making recommendations about the advisability of buying or selling property and, directly or indirectly (1) has discretionary authority with respect to buying or selling property, or (2) renders advice on a regular basis to the plan, pursuant to a mutual understanding that (x) the services will be the primary basis for investment decisions, and (y) he or she will render individualized advice regarding investment policies.<a href="#_ftn2" name="_ftnref2">2</a> Whether advice and recommendations regarding plan purchases of insurance contracts and annuities constitute investment advice depends on the facts in each situation.<a href="#_ftn3" name="_ftnref3">3</a> A fee or other compensation can include insurance sales commissions. A final rule issued by the Department of Labor (DOL) in 2016 broadened the definition of fiduciary, effective April 10, 2017<a href="#_ftn4" name="_ftnref4">4</a> to include a person who gives fiduciary investment advice to a plan, plan fiduciary, participant, beneficiary, or IRA owner. It was vacated on June 21, 2018 after the Fifth Circuit Court of Appeals issued a mandate. The DOL did not appeal, and instead proposed a new class exemption which has again been modified as of 2024. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>.<a href="#_ftn5" name="_ftnref5">5</a> Under earlier DOL regulations, a person who develops a computer model or who markets a computer model or investment advice program used in an ‘‘eligible investment advice arrangement’’ is a fiduciary of a plan by reason of the provision of investment advice and is treated as a ‘‘fiduciary advisor.’’<a href="#_ftn6" name="_ftnref6">6</a> The regulations specify the conditions that must be met for a fiduciary to elect to be the sole fiduciary advisor under the investment advice program. ERISA does not modify the definition of a fiduciary under IRC Section 4975; consequently, an individual who is not a fiduciary under ERISA still can be a fiduciary for purposes of IRC Section 4975.<a href="#_ftn7" name="_ftnref7">7</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 4975(e)(3). <a href="#_ftnref2" name="_ftn2">2</a>.  Treas. Reg. § 54.4975-9(c). <a href="#_ftnref3" name="_ftn3">3</a>.  Prohibited Transaction Exemption (PTE) 77-9 (Discussion of Major Comments). <a href="#_ftnref4" name="_ftn4">4</a>.  29 C.F.R. § 2510.3-21(a). <a href="#_ftnref5" name="_ftn5">5</a>.  Chamber of Commerce v. Acosta, No. 17-10238 (5th Cir. June 21, 2018). <a href="#_ftnref6" name="_ftn6">6</a>.  DOL Reg. § 2550.408g–2; IRC § 4975(f)(8). <a href="#_ftnref7" name="_ftn7">7</a>.  Flahertys Arden Bowl, Inc. v. Comm., 115 TC 269 (2000), aff’d, 262 F. 3d 1162, 88 AFTR 2d 2001-5547 (8th Cir. 2001). </div></div>

March 13, 2024

3992 / What are the penalties for engaging in a prohibited transaction?

<div class="Section1"> A first tier tax equal to 15 percent of the amount involved is imposed on each prohibited transaction for each year or part thereof from the time the transaction occurs until the earliest of the date: (1) it is corrected, (2) a deficiency notice is mailed, or (3) the tax is assessed.<a href="#_ftn1" name="_ftnref1">1</a> An employer fined under this provision for failing to make timely 401(k) transfer deferrals was assessed the 15 percent penalty only on the amount of interest the employer would have paid for a bank loan for the same amount, not 15 percent of the amount of the late deposit.<a href="#_ftn2" name="_ftnref2">2</a> All disqualified persons who participate in the prohibited transaction, other than a fiduciary acting only as a fiduciary, are jointly and severally liable for the full amount of the tax. A trustee was held liable for the tax even though the trustee did not vote to approve the payment that was determined to be a prohibited transaction; the Seventh Circuit Court of Appeals determined that the trustee had benefited from the payments and thus had participated in the transaction.<a href="#_ftn3" name="_ftnref3">3</a> An act of self-dealing involving the use of money or property (for example, the leasing of property) may be treated as giving rise to multiple transactions – one on the day the transaction occurs and separate ones on the first day of each taxable year within the above period – and, thus, may result in multiple penalties.<a href="#_ftn4" name="_ftnref4">4</a> Second Tier Tax If a transaction is not corrected within the above period, there is a second tier tax of 100 percent of the amount involved. This tax will be abated if the transaction is corrected within 90 days after the notice of deficiency with respect to the additional tax is mailed. This 90-day period may be extended in certain circumstances. To be corrected, the transaction must be undone to the extent possible, but, in any event, so as to place the plan in a financial position no worse than it would have been in had the disqualified person acted under the highest fiduciary standards.<a href="#_ftn5" name="_ftnref5">5</a> A prohibited transaction was held to be self-correcting, and thus not subject to the second tier tax (or to the first tier tax in subsequent tax years), where the extraordinary success of the investment was such that to undo the transaction would have put the plan in a worse position than if the disqualified persons had acted under the highest fiduciary standards. Essentially, the transaction involved a sale of mineral rights that were producing over a million dollars a year in royalties to an ESOP by the employees of the employer in return for a private annuity.<a href="#_ftn6" name="_ftnref6">6</a> The Tax Court considers this case to be an anomaly and has stated that, in general, prohibited transactions cannot be self-correcting.<a href="#_ftn7" name="_ftnref7">7</a> If the owner of an individual retirement account, or the owner’s beneficiary, engages in a prohibited transaction and, as a result, the account ceases to be an individual retirement account, the tax does not apply ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3649">3649</a>). Similar rules apply to beneficiaries of health and Archer medical savings accounts ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="390">390</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="422">422</a>) and to beneficiaries of and contributors to education savings accounts.<a href="#_ftn8" name="_ftnref8">8</a> The IRS has the authority to impose tax penalties as a result of prohibited transactions, even when the Department of Labor has entered into a consent judgment concerning the plan.<a href="#_ftn9" name="_ftnref9">9</a> Other Consequences In addition to the potential tax penalties discussed above, there can be other consequences to a prohibited transaction. IRAs cease to qualify as IRAs as of the first day of the taxable year in which the prohibited transaction occurs and the account is treated as distributing all of its assets on that date.<a href="#_ftn10" name="_ftnref10">10</a> A self-directed IRA purchased land and contributed it and cash to a partnership with an LLC solely owned by the IRA owner and his wife that owned the adjacent property. It allowed the IRA owner to use the IRA assets for his personal benefit. Because the IRA owner was a fiduciary with regard to the IRA, this was a prohibited transaction and immediately terminated the IRA’s exempt status. As a result, the IRA assets were not protected when the IRA owner filed for bankruptcy.<a href="#_ftn11" name="_ftnref11">11</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 4975(a); IRC § 4975(f)(2). <a href="#_ftnref2" name="_ftn2">2</a>.  Rev. Rul. 2006-38, 2006-29 IRB 80. <a href="#_ftnref3" name="_ftn3">3</a>.  O’Malley v. Comm., 972 F.2d 150 (7th Cir. 1992). <a href="#_ftnref4" name="_ftn4">4</a>.  Treas. Reg. § 141.4975-13. See Lambos v. Comm., 88 TC 1440 (1987). <a href="#_ftnref5" name="_ftn5">5</a>.  IRC §§ 4975(b), 4961. <a href="#_ftnref6" name="_ftn6">6</a>.  Zabolotny v. Comm., 7 F.3d 774 (8th Cir. 1993), nonacq. 1994-1 CB 1. <a href="#_ftnref7" name="_ftn7">7</a>.  Morrissey v. Comm., TC Memo 1998-443. <a href="#_ftnref8" name="_ftn8">8</a>.  IRC § 4975(c)(3). <a href="#_ftnref9" name="_ftn9">9</a>.  Baizer v. Comm., 204 F.3d 1231 (9th Cir. 2000). <a href="#_ftnref10" name="_ftn10">10</a>.  IRC § 408(e)(2). <a href="#_ftnref11" name="_ftn11">11</a>.  In Re Kellerman, 115 AFTR 2d 2015-1944 (Bktcy. Ct. AR 2015). </div></div>

March 13, 2024

3984 / When is a plan loan exempted from the prohibited transaction rules?

<div class="Section1"> Loans made to plan participants and beneficiaries generally are exempted from the prohibited transaction rules if the loans: (1)  are made available to all participants and beneficiaries on a reasonably equivalent basis, (2)  are not made available to highly compensated employees ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3930">3930</a>) in an amount greater than the amount made available to other employees, (3)  are made in accordance with specific provisions regarding such loans set forth in the plan, (4)  bear reasonable rates of interest, and (5)  are adequately secured.<a href="#_ftn1" name="_ftnref1">1</a> A reasonable rate of interest is one that provides the plan with a return commensurate with the interest rates charged by persons in the business of lending money for loans made under similar circumstances.<a href="#_ftn2" name="_ftnref2">2</a> Security for participant loans is considered adequate if it may reasonably be anticipated that loss of principal or interest will not result if default occurs.<a href="#_ftn3" name="_ftnref3">3</a> The effect of this no loss requirement varies depending on the type of plan; a plan in which the investment experience of the plan’s assets is shared by all participants may require additional loan conditions, such as mandatory payroll deduction repayment on stated events or additional collateral. No more than 50 percent of the present value of a participant’s vested accrued benefit under a plan generally may be considered as security for the outstanding balance of all plan loans made to the participant.<a href="#_ftn4" name="_ftnref4">4</a> Except in the case of directed investment loans, this loan exemption is not an exemption from the other fiduciary standards of ERISA. The prohibited transaction rules apply to a loan that does not meet the exemption requirements, even if it is treated and taxed as a distribution ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3953">3953</a>).<a href="#_ftn5" name="_ftnref5">5</a> Loans from a qualified plan to S corporation shareholders, partners, and sole proprietors generally are exempt from the prohibited transaction rules ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3953">3953</a>),<a href="#_ftn6" name="_ftnref6">6</a> although there are rules applying to certain S corporation ESOPs that the IRS views as abusive ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3825">3825</a>). The Tax Court determined that a loan between a plan and a corporation partially owned by a disqualified person did not constitute a prohibited transaction where the loan was approved by and made at the sole discretion of the plan’s independent bank trustee.<a href="#_ftn7" name="_ftnref7">7</a> A transfer of property to a plan in satisfaction of a participant loan was treated as a prohibited transaction where the borrower was a disqualified person.<a href="#_ftn8" name="_ftnref8">8</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  ERISA § 408(b)(1); IRC § 4975(d)(1); Labor Reg. § 2550.408b-1. <a href="#_ftnref2" name="_ftn2">2</a>.  Labor Reg. § 2550.408b-1(e). <a href="#_ftnref3" name="_ftn3">3</a>.  Labor Reg. § 2550.408b-1(f)(1). <a href="#_ftnref4" name="_ftn4">4</a>.  Labor Reg. § 2550.408b-1(f)(2). <a href="#_ftnref5" name="_ftn5">5</a>.  Medina v. U.S., 112 TC 51 (1999). <a href="#_ftnref6" name="_ftn6">6</a>.  IRC § 4975(f)(6)(B)(iii). <a href="#_ftnref7" name="_ftn7">7</a>.  Greenlee v. Comm., TC Memo 1996-378. <a href="#_ftnref8" name="_ftn8">8</a>.  Morrissey v. Comm., TC Memo 1998-443. </div></div>

March 13, 2024

3983 / What exemptions to the prohibited transaction rules are provided by the Internal Revenue Code?

<div class="Section1"> The IRC lists specific exemptions from the broad prohibited transaction rules. These include: (1)  the receipt of benefits under the terms of the plan; (2)  the distribution of the assets of the plan meeting allocation requirements; (3)  loans available to all plan participants or beneficiaries under certain circumstances (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3984">3984</a>); (4)  a loan to an employee stock ownership plan (ESOP, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3817">3817</a>); and (5)  the acquisition or sale of qualifying employer securities by an individual account profit sharing, stock bonus, thrift, savings plan, or ESOP for adequate consideration and without commission.<a href="#_ftn1" name="_ftnref1">1</a> Another statutory exemption is for the provision of office space or services necessary for the establishment or operation of the plan under a reasonable arrangement for no more than reasonable compensation.<a href="#_ftn2" name="_ftnref2">2</a> This exemption shields only the provision of services that would be prohibited transactions under (1), (3), and (4) in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3980">3980</a>, not fiduciary self-dealing. Thus, if an insurance agent is not a fiduciary, the agent’s sale of insurance to a plan and receipt of a commission is within this statutory exemption. If an agent is a fiduciary (for example, if the trustee relies on his or her investment advice) receipt of a commission for sale of insurance or annuities to a plan may be a prohibited transaction.<a href="#_ftn3" name="_ftnref3">3</a> Certain administrative exemptions (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3985">3985</a>) permit receipt of fees or commissions by fiduciaries in connection with the sale of insurance and annuity contracts to plans and the transfer of insurance contracts between plan and plan participants or employers. Final DOL regulations provide that compensation paid to certain service providers will not be considered reasonable for purposes of the prohibited transaction exemption unless the covered service provider satisfies a fee disclosure mandate.<a href="#_ftn4" name="_ftnref4">4</a> Failure to comply with the disclosure mandate will mean that compensation paid to the covered service provider does not qualify for the statutory prohibited transaction exemption. The service providers covered by the mandate are fiduciaries, registered investment advisors, platform providers for participant directed defined contribution plans, and other indirectly compensated service providers who reasonably expect $1,000 or more in direct or indirect compensation in connection with providing covered services. Indirectly compensated services include accounting, auditing, actuarial, appraisal, banking, certain consulting related to the plan or plan investments, custodial, insurance, investment advisory, legal, recordkeeping, investment brokerage, third party administration, or valuation services provided to the plan for which the covered service provider, an affiliate, or subcontractor reasonably expects to receive indirect compensation.<a href="#_ftn5" name="_ftnref5">5</a> Direct compensation is compensation received directly from the plan. Indirect compensation is compensation received from any source other than the plan, the plan sponsor, the covered service provider, or an affiliate. Compensation received from a subcontractor is generally indirect compensation.<a href="#_ftn6" name="_ftnref6">6</a> The disclosure must include the following information: (1)  A description of the services to be provided; (2)  If applicable, a statement that the services will be provider as a fiduciary, as a registered investment advisor, or both; (3)  A description of all direct and indirect compensation expected to be received; (4)  If recordkeeping services will be provided to the plan, a description of the compensation expected to be received for the services and information about any arrangement where the recordkeeping services will be provided without explicit compensation; (5)  Information about fiduciary services provided to investment products that the plan has a direct equity investment in; (6)  Information about investment products made available through a platform in connection with recordkeeping and brokerage services; and (7)  A description of the manner in which the compensation will be received, such as whether the plan will be billed or the compensation will be deducted directly from the plan’s accounts or investments.<a href="#_ftn7" name="_ftnref7">7</a> Except for the first two exemptions listed above, these statutory exemptions do not apply where a plan that covers owner-employees (1) lends assets or income, (2) pays any compensation for personal services rendered to the plan, or (3) except as described in the following paragraph, acquires property from or sells property to (x) an owner-employee ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3932">3932</a>) or an employee who owns more than 5 percent of the outstanding shares of an S corporation, an individual retirement plan participant, beneficiary, or sponsoring employer or association, as the case may be, (y) a family member of a person described in (x), or (z) a corporation controlled by a person described in (x) through ownership of 50 percent or more of total combined voting power of all classes of stock or 50 percent or more of total shares of all classes of stock of the corporation.<a href="#_ftn8" name="_ftnref8">8</a> A transaction consisting of a sale of employer securities to an ESOP ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3819">3819</a>) by a shareholder-employee, a member of his or her family, or a corporation in which he or she owns 50 percent or more of the stock generally will be exempt from the prohibited transaction rules. For this purpose, a shareholder-employee is an employee or officer of an S corporation who owns or is deemed to own, under the constructive ownership rules of IRC Section 318(a)(1), more than 5 percent of the outstanding stock of the corporation on any day during the corporation’s taxable year.<a href="#_ftn9" name="_ftnref9">9</a> For special rules applying to S corporation ESOPs that the IRS views as abusive, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3825">3825</a>. The Pension Protection Act of 2006 created an exemption from the prohibited transaction rules for certain fiduciary advisors who provide investment advice under an eligible investment advice arrangement ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3793">3793</a>).<a href="#_ftn10" name="_ftnref10">10</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 4975(d). <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 4975(d)(2). <a href="#_ftnref3" name="_ftn3">3</a>.  PTE 77-9 (Discussion of Major Comments); see Treas. Reg. § 54.4975-6(a)(5). <a href="#_ftnref4" name="_ftn4">4</a>.  Labor Reg. § 2550.408b-2. <a href="#_ftnref5" name="_ftn5">5</a>.  Labor Reg. § 2550.408b-2(c)(1)(iii). <a href="#_ftnref6" name="_ftn6">6</a>.  Labor Reg. § 2550.408b-2(c)(1)(viii)(B). <a href="#_ftnref7" name="_ftn7">7</a>.  Labor Reg. § 2550.408b-2(c)(1)(iv). <a href="#_ftnref8" name="_ftn8">8</a>.  IRC § 4975(f)(6)(A). <a href="#_ftnref9" name="_ftn9">9</a>.  IRC §§ 4975(f)(6)(B)(ii), 4975(f)(6)(C). <a href="#_ftnref10" name="_ftn10">10</a>.  IRC §§ 4975(d)(17), 4975(f)(8), ERISA § 408(g). </div></div>

July 14, 2020

3987 / When does the DOL investment advice fiduciary PTE 2020-02 apply to rollover transactions?

<div class="Section1"> In the finalized fiduciary release, the DOL was clear that one-time recommendations (including rollovers and annuity sales) can create fiduciary liability under the 2024 definition of investment advice fiduciary. The DOL has stated that under the old five-part test, investment advice “provided on a "one-time" basis, like many recommendations to roll retirement savings out of a workplace retirement plan and into an IRA, was typically not treated as fiduciary advice and therefore was not protected by ERISA's fiduciary safeguards. Yet, one-time advice is often the most important advice the retirement investor will ever receive…. The new rule and exemptions close the loopholes that defeat legitimate investor expectations by holding trusted advisers to a fiduciary standard. When an individualized recommendation comes from an investment professional holding themselves out as someone who is acting in the investor's best interest, it is only right that the advice meet a fiduciary standard.” The DOL exemption for fiduciary advice specifically applies to rollover advice, assuming the circumstances qualify under the test for determining whether the advisor is an investment advice fiduciary (see Q 3986). Rollovers from a 401(k) to an IRA, IRA to IRA, or one type of account to another (i.e., from a fee-based account to a commission-based account) are all potentially covered by the exemption. Under the 1975 five-part test, which now no longer applies, the DOL commentary included with the exemption stated that not every rollover triggered investment advice fiduciary status. A facts-and-circumstances analysis was required in every case to determine whether the transaction was subject to the new standard. Specifically, the DOL noted that it did not intend to apply the guidance in DOL Advisory Opinion 2005-23A (the Deseret Letter), which would have found that rollover advice generally does not constitute investment advice. Under the 2024 rule, if the one-time recommendation otherwise causes the advisor or firm to obtain fiduciary status, PTE 2020-02 may be available. Rollovers, annuity sales and other one-time transactions can now all create fiduciary status that requires compliance with one of the PTEs and the impartial conduct standards. Text for Rollover Status Under the Old Five-Part Test Under the now-void five-part test, all five prongs of the test must be satisfied for the advisor to be an investment advice fiduciary under the DOL definition. Advice to execute a rollover transaction can potentially be an isolated event that would not satisfy the “regular basis” component of the five-prong approach. On the other hand, rollover advice can be given as a part of an ongoing relationship between client and advisor, or an anticipated future ongoing relationship between the parties. Further, determining whether there is a “mutual understanding” between the parties is based upon the reasonable understanding of both parties—even if no formal agreement is found. In fact, the DOL notes that advice to roll over plan assets is often given for the purpose of establishing an ongoing relationship where advice is provided on a regular basis outside of the plan (in return for a fee/commission). In other words, the rollover advice can be the first step in an investment advisory relationship that continues on a regular basis. The exemption requires financial firms and advisors to document the reasons for recommending the rollover, including why the rollover is in the client’s best interests. </div>

March 20, 2019

3989 / What is the PTE that permits disqualified persons other than a plan to make unsecured interest-free loans to a plan to pay ordinary operating expenses?

<div class="Section1"> Administrative Exemption: 80-26 Prohibited Transaction Exemption 80-26<a href="#_ftn1" name="_ftnref1">1</a> permits a disqualified person other than another plan to make unsecured interest-free loans to a plan to pay ordinary operating expenses (including the payment of benefits and periodic premiums under an insurance or annuity contract) or, for a period no longer than three days, for a purpose incidental to the ordinary operation of the plan. The Department of Labor adopted a temporary amendment to PTE 80-26 to include interest-free loans made to plans affected by the 9/11 terrorist attacks.<a href="#_ftn2" name="_ftnref2">2</a> In 2006, the Department amended the regulation to eliminate the three-day limit, provided that if the loan is for longer than 60 days, the terms of the agreement are written.<a href="#_ftn3" name="_ftnref3">3</a> An amendment proposed in 2013 would provide retroactive and temporary relief for certain guarantees of the payment of debits to plan investment accounts (including IRAs) by parties in interest to such plans as well as certain loans and loan repayments made pursuant to such guarantees.<a href="#_ftn4" name="_ftnref4">4</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. 1980-2 CB 323. <a href="#_ftnref2" name="_ftn2">2</a>. Temp. Amendments to PTE 80-26. 67 Fed. Reg. 9485 (Mar. 3, 2002). <a href="#_ftnref3" name="_ftn3">3</a>. 67 Fed. Reg. 17917 (Apr. 7, 2006). <a href="#_ftnref4" name="_ftn4">4</a>. 78 Fed. Reg. 31584. </div>